Where are muniland’s cross-over buyers?

It’s an odd moment in muniland. There is an irregularity in the pricing of municipal bonds. Generally muni bonds have a lower yield than U.S. Treasuries because munis give investors a tax advantage. Investors use them to shield their investment income since coupon payments on municipal bonds from their state of residence are generally triple-tax-free — that is, they are not taxed at the local, state or federal level.

In this Bloomberg video Timothy Pynchon, a portfolio manager at Pioneer Investment Management, talks about how 30-year muni bonds are trading at 105 percent of the value of the 30-year Treasury. These bonds would usually trade at less than 100 percent of Treasuries because of their tax advantages. This is a very unusual situation and would usually attract so-called “cross-over” buyers from other parts of the bond market. In the video, Cumberland Advisors’ David Kotok suggests that since U.S. Treasuries are mispriced (too expensive with low yields as a result of a flight to quality) it’s having a carry-over effect for long-dated municipal bonds. Basically the long end of the municipal bond market has moved away from its normal pricing relationships and is cheap relative to Treasuries.

I’ve written several times that the potential bankruptcy of Jefferson County, Alabama is not the harbinger of a massive wave of defaults but rather a situation ridden with massive corruption. The corruption began in the late 1990s when sewer project contractors began overcharging. Many of them went to prison. The corruption was also a symbiotic dance between public officials and underwriters. It’s instructive to learn from what happened on this project so that public officials act with caution on the recommendations of underwriters. Wall Street’s preying upon municipal governments must stop. The Birmingham News has an excellent report today:

Christopher “Kit” Taylor, a financial consultant in Alexandria, Va. [and former chairman of the Municipal Securities Rulemaking Board], who has followed the county’s sewer debt crisis since 2008, said there was corruption on both sides.

“Did the county have a bunch of corrupt officials? Yes. Were some of the underwriters corrupt? Were the advisers around it taking advantage of the situation knowing it was bad, but disclaiming any liability? Yes,” he said. “They all took advantage of it. What we had here was a wholly corrupt situation and everybody bears a responsibility for it.”

Said UAB’s Rauterkus [Andreas Rauterkus, a finance professor at the University of Alabama at Birmingham]: “In order to be criminal, somebody actually has to put you in a position that you can be one. In other words, yes, there is a lot of corruption that went on in Jefferson County, but somebody was actually paying the bribes and they worked the other side of the deal. All of this comes out of a corporate culture. Even if it’s not condoned there’s certainly a culture of, ‘you need to make the deal under any circumstance.'”